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1、Chapter 6TheRiskandTermStructureofInterestRates 2005 Pearson Education Canada Inc.Risk Structure of Long-Term Bonds in Canada2 2005 Pearson Education Canada Inc.Increase in Default Risk on Corporate Bonds3 2005 Pearson Education Canada Inc.Analysis of Figure 6-2:Increase inDefault Risk on Corporate
2、BondsCorporate Bond Market1.Reoncorporatebonds,Dc,Dcshiftsleft2.Riskofcorporatebonds,Dc,Dcshiftsleft3.Pc,icCanada Bond Market4.RelativeReonCanadabonds,DT,DTshiftsright5.RelativeriskofCanadabonds,DT,DTshiftsright6.PT,iTOutcome:Riskpremium,ic iT,rises4 2005 Pearson Education Canada Inc.Bond Ratings5 2
3、005 Pearson Education Canada Inc.Corporate Bonds Become Less LiquidCorporate Bond Market1.LessliquidcorporatebondsDc,Dcshiftsleft2.Pc,icCanada Bond Market1.RelativelymoreliquidCanadabonds,DT,DTshiftsright2.PT,iTOutcome:Riskpremium,ic iT,risesRiskpremiumreflectsnotonlycorporatebondsdefaultrisk,butals
4、olowerliquidity6 2005 Pearson Education Canada Inc.Tax Advantages of Municipal Bondsin the United States7 2005 Pearson Education Canada Inc.Analysis of Previous Figure:Tax Advantages of Municipal BondsMunicipal Bond Market in the United States1.TaxexemptionraisesrelativeRETeonU.S.municipalbonds,Dm,D
5、mshiftsright2.Pm,imU.S.Treasury Bond Market1.RelativeRETeonTreasurybonds,DT,DTshiftsleft2.PT,iTOutcome:imiT8 2005 Pearson Education Canada Inc.Term Structure Facts to be Explained1.Interestratesfordifferentmaturitiesmovetogetherovertime2.Yieldcurvestendtohavesteepupwardslopewhenshortratesarelowanddo
6、wnwardslopewhenratesarehigh3.YieldcurveistypicallyupwardslopingThree Theories of Term Structure1.ExpectationsTheory2.SegmentedMarketsTheory3.LiquidityPremium(PreferredHabitat)TheoryA.ExpectationsTheoryexplains1and2,butnot3B.SegmentedMarketsexplains3,butnot1and2C.Solution:CombinefeaturesofbothExpecta
7、tionsTheoryandSegmentedMarketsTheorytogetLiquidityPremium(PreferredHabitat)Theoryandexplainallfacts 2005 Pearson Education Canada Inc.9Interest Rates on Different Maturity Bonds Move Together10 2005 Pearson Education Canada Inc.Yield Curves11 2005 Pearson Education Canada Inc.Expectations Hypothesis
8、Key Assumption:BondsofdifferentmaturitiesareperfectsubstitutesImplication:RETeonbondsofdifferentmaturitiesareequalInvestmentstrategiesfortwo-periodhorizon1.Buy$1ofone-yearbondandwhenitmaturesbuyanotherone-yearbond2.Buy$1oftwo-yearbondandholditExpected return from strategy 2(1+i2t)(1+i2t)11+2(i2t)+(i
9、2t)21=11Since(i2t)2isextremelysmall,expectedreturnisapproximately2(i2t)12 2005 Pearson Education Canada Inc.Expected Return from Strategy 1(1+it)(1+iet+1)11+it+iet+1+it(iet+1)1=11Sinceit(iet+1)isalsoextremelysmall,expectedreturnisapproximatelyit+iet+1Fromimplicationaboveexpectedreturnsoftwostrategie
10、sareequal:Therefore2(i2t)=it+iet+1Solvingfori2tit+iet+1 i2t=213 2005 Pearson Education Canada Inc.Expected Return from Strategy 1More generally for n-period bond:it+iet+1+iet+2+.+iet+(n1)int=nIn words:Interestrateonlongbond=averageshortratesexpectedtooccuroverlifeoflongbondNumerical example:One-year
11、interestrateoverthenextfiveyears5%,6%,7%,8%and9%:Interest rate on two-year bond:(5%+6%)/2=5.5%Interest rate for five-year bond:(5%+6%+7%+8%+9%)/5=7%Interest rate for one to five year bonds:5%,5.5%,6%,6.5%and7%.2005 Pearson Education Canada Inc.14Expectations Hypothesis and Term Structure FactsExplai
12、ns why yield curve has different slopes:1.Whenshortratesexpectedtoriseinfuture,averageoffutureshortrates=intisabovetodaysshortrate:thereforeyieldcurveisupwardsloping2.Whenshortratesexpectedtostaysameinfuture,averageoffutureshortratesaresameastodays,andyieldcurveisflat3.Onlywhenshortratesexpectedtofa
13、llwillyieldcurvebedownwardslopingExpectations Hypothesis explains Fact 1 that short and long rates move together1.Shortraterisesarepersistent2.Ifittoday,iet+1,iet+2etc.averageoffutureratesint3.Therefore:itint,i.e.,shortandlongratesmovetogether15 2005 Pearson Education Canada Inc.1.Whenshortratesarel
14、ow,theyareexpectedtorisetonormallevel,andlongrate=averageoffutureshortrateswillbewellabovetodaysshortrate:yieldcurvewillhavesteepupwardslope2.Whenshortratesarehigh,theywillbeexpectedtofallinfuture,andlongratewillbebelowcurrentshortrate:yieldcurvewillhavedownwardslopeDoesnt explain Fact 3 that yield
15、curve usually has upward slopeShortratesaslikelytofallinfutureasrise,soaverageoffutureshortrateswillnotusuallybehigherthancurrentshortrate:therefore,yieldcurvewillnotusuallyslopeupwardExplains Fact 2 that yield curves tend to have steep slope when short rates are low and downward slope when short ra
16、tes are high16 2005 Pearson Education Canada Inc.Segmented Markets TheoryKey Assumption:BondsofdifferentmaturitiesarenotsubstitutesatallImplication:Marketsarecompletelysegmented:interestrateateachmaturitydeterminedseparatelyExplains Fact 3 that yield curve is usually upward slopingPeopletypicallypre
17、fershortholdingperiodsandthushavehigherdemandforshort-termbonds,whichhavehigherpriceandlowerinterestratesthanlongbondsDoes not explain Fact 1 or Fact 2 because assumes long and short rates determined independently17 2005 Pearson Education Canada Inc.Liquidity Premium(Preferred Habitat)TheoriesKey As
18、sumption:Bondsofdifferentmaturitiesaresubstitutes,butarenotperfectsubstitutesImplication:ModifiesExpectationsTheorywithfeaturesofSegmentedMarketsTheoryInvestorsprefershortratherthanlongbondsmustbepaidpositiveliquidity(term)premium,lnt,toholdlong-termbondsResultsinfollowingmodificationofExpectationsT
19、heory it+iet+1+iet+2+.+iet+(n1)int=+lntn18 2005 Pearson Education Canada Inc.Relationship Between the Liquidity Premium(Preferred Habitat)and Expectations Theories19 2005 Pearson Education Canada Inc.Numerical Example1.One-yearinterestrateoverthenextfiveyears:5%,6%,7%,8%and9%2.Investorspreferencesfo
20、rholdingshort-termbonds,liquiditypremiumsforonetofive-yearbonds:0%,0.25%,0.5%,0.75%and1.0%.Interestrateonthetwo-yearbond:(5%+6%)/2+0.25%=5.75%Interestrateonthefive-yearbond:(5%+6%+7%+8%+9%)/5+1.0%=8%Interestratesononetofive-yearbonds:5%,5.75%,6.5%,7.25%and8%.Comparingwiththosefortheexpectationstheor
21、y,liquiditypremium(preferredhabitat)theoriesproduceyieldcurvesmoresteeplyupwardsloped20 2005 Pearson Education Canada Inc.Liquidity Premium(Preferred Habitat)Theories:Term Structure FactsExplains all 3 FactsExplainsFact3ofusualupwardslopedyieldcurvebyinvestorspreferencesforshort-termbondsExplainsFac
22、t1andFact2usingsameexplanationsasexpectationshypothesisbecauseithasaverageoffutureshortratesasdeterminantoflongrate21 2005 Pearson Education Canada Inc.Market Predictions of Future Short Rates22 2005 Pearson Education Canada Inc.Interpreting Yield Curves 1990200323 2005 Pearson Education Canada Inc.